In 1913, Albert Einstein was working on his theory of gravity, Richard Nixon was born, and Franklin D. Roosevelt was sworn in as Assistant Secretary of the Navy. It was also the year Woodrow Wilson took the oath of office as the 28th President of the United States, intent on advocating progressive reform and change. One of his biggest reforms came on December 23, 1913, when he signed the Federal Reserve Act into law. This landmark legislation created the Federal Reserve System, the nation’s central bank.

A Need for Stability

Why was a central bank needed? After the charter of the Second Bank of the United States expired in 1836, the United States endured a series of financial crises throughout the 19th century and into the first decade of the 20th century. When the Knickerbocker Trust Company
in New York City failed in 1907, it triggered runs on other trust companies, as well as hundreds of bank failures, a decrease in the money supply, and a deep recession. In
response, Congress set up the National Monetary Commission in 1908. The commission submitted a report to Congress four years later that proposed a plan to create a National Reserve Association of the United States. The actual plan was never implemented; however, it sparked
a debate advocating a new central bank for the United States: the Federal Reserve System. Incoming President Wilson favored adding a central governmental board to oversee the reserve banks.

Among the many proposals introduced to Congress in 1913, Representative Carter Glass sponsored the key bill passed by the House and finally by the Senate on December 19, 1913. Four days later, President Woodrow Wilson signed the bill into law, creating the Federal Reserve System.

In part, the Federal Reserve Act established the Reserve Bank Organization Committee, in which the Secretary of the Treasury, the Secretary of Agriculture, and the Comptroller of the Currency would divide the nation into no fewer than eight and no more than 12 Federal Reserve Districts. The committee was also charged with deciding which cities would host a Federal Reserve Bank, how the geographic boundaries of each Federal Reserve District would be defined, and how the Reserve Banks would be organized and supervised.

Between January and mid-February 1914, the committee held meetings in 18 cities across the nation. Local businessmen, bankers, farmers, and others made a case explaining why their city or state should be chosen as a Reserve Bank location. In April 1914, the committee submitted a report to Congress listing the cities it had selected for the Reserve Banks, the same cities that host Reserve Banks today.

The Federal Reserve Act also provided an operating structure for the Reserve System: It created a Federal Reserve Board in Washington, D.C., designed to oversee the operations
of the Reserve Banks. The Board consisted of seven members, including the Secretary of the Treasury and the Comptroller of the Currency as ex officio members, as well as five members appointed by the President of the United States and confirmed by the Senate.

PANICS AND CRISES

The Knickerbocker Trust Company, the second largest of its kind in New York, failed in October 1907, which led to runs on other trust companies. Knickerbocker did not have enough cash on hand to meet depositors’ demand. Since there was no deposit insurance in 1907 and no lender of last resort to turn to, the run triggered a panic that launched hundreds of bank failures, a significant decrease in the money supply, and a deep recession. Financier J.P. Morgan formed a syndicate with his fellow bankers to put sufficient liquidity into the economy to quell the panic. Congress then set up a federal commission to study the economy, which eventually led to the creation of the Federal Reserve System in 1913.

But before the Federal Reserve System was established, the United States faced another crisis in July 1914. European investors, who owned more than 20 percent of American railroad stocks, started to sell these assets to secure a flow of gold to Europe to help pay for World War I. This sell-off put a serious drain on the U.S. gold supply, weakening the
gold-backed dollar and making it hard for the U.S. to maintain the gold standard. Although Treasury Secretary William McAdoo tried to push for the Federal Reserve Banks to open early, his attempt was thwarted. So he moved to close Wall Street “to hamper British sales of American securities.” The stock market closed on July 31, 1914, and reopened on
December 12.

On November 16, 1914, all 12 regional Reserve Banks opened for business. Like the First Bank and the Second Bank of the United States, the Fed was initially given a 20-year charter. However, the McFadden Act of 1927 removed the 20-year limit. This helped the Federal Reserve
avoid the political battle over rechartering, which had ended both previous attempts at a central bank.

Off to a Rough Start

With the nation’s economy still unsettled, the Roaring Twenties were largely remembered as a period of economic prosperity and a rising stock market, despite three recessions. Middle class and wealthier households benefited from the boom, but not everyone shared in the prosperity. During the decade, crop prices collapsed, and as a result, many farmers defaulted on their mortgages. However, the Fed continued an accommodative monetary policy throughout 1927. Then in 1928, the Fed finally raised interest rates, but this proved to be too little too late. It further aggravated the economic situation by slowing down an already faltering economy. By 1929, the stock market crash deepened the crisis and triggered the Great Depression.

WORKS OF GLASS (1858-1946)

Carter Glass, the son of a newspaperman, was born in
Lynchburg, VA. After attending school and working as a printer’s apprentice, reporter, editor, and owner of a newspaper, he was elected to the state senate in 1899 and served as a delegate to Virginia’s constitutional convention. After he was elected to the U.S. House of Representatives in 1902, he was appointed to the Committee on Banking and Currency. During the Panic of 1907, Glass saw the need to reduce, if not eliminate, the number of bank panics and financial crises as well as develop the need for a more elastic currency.
Glass was Secretary of the Treasury from 1918 to 1920 and served in the Senate. One of his biggest accomplishments was his work on the bill that would become the Federal Reserve Act of 1913.

President Herbert Hoover attempted to stimulate the economy by urging Congress to pass the Reconstruction Finance Corporation (RFC) Act of 1932. The RFC was established to make loans to banks and other financial institutions and to lend funds to railroads, many of which could not meet their bond payments.

However, many people criticized Hoover, saying his actions weren’t fast enough and didn’t go far enough to stem the rise of bank failures and growing unemployment. Voters decided it was time for a change. Hoover lost the presidential election in November 1932, and voters sent Franklin D. Roosevelt to the White House. Although other factors, including the collapse of international trade, contributed to the severe economic distress
in the United States, the breakdown of the banking system was credited with being the major cause of the Depression. Between 1930 and 1933, 9,000 banks failed in the United States. These bank failures limited money supply, which, in turn, led to a decline in spending on
goods and services. Firms lowered their prices and laid off workers. As incomes dwindled, many households defaulted on loans, and bankruptcies escalated.

Trust in banks evaporated. People withdrew their savings from banks and began hoarding cash. Bank reserves plunged, which resulted in tighter credit. In March 1933, Roosevelt declared a bank holiday, in which all U.S. banks were closed for four business days. After Congress passed the Emergency Banking Act on March 9, the Federal Reserve agreed to supply an unlimited amount of emergency money to the banks that reopened. This commitment by the Fed essentially created an early form of deposit insurance. These measures went a long way toward restoring the public’s confidence in banks. By the end of March 1933, two-thirds of the money that had been withdrawn in earlier bank runs and panics had been
redeposited in the nation’s banks.

However, the Fed did not respond aggressively; it continued its tight monetary policy for too long, and prices started to fall, leading to widespread deflation. When banks did close their doors, people lost their savings and credit became scarce.

Congress passed many important pieces of legislation in response to the Great Depression. The Banking Act of 1933 created the Federal Deposit Insurance Corporation (FDIC) as a temporary government agency with the authority to provide deposit insurance to banks, initially insuring bank deposits up to $2,500. This act, known as the Glass-Steagall Act, separated investment banking from commercial banking and established the Federal Open Market Committee (FOMC). Although the Federal Reserve Banks had set up an Open Market Investment
Committee in 1923, the Reserve Banks were not obligated to carry out the committee’s recommendations. The 1933 law also gave the Federal Reserve Board the responsibility
for supervising bank holding companies.

The Banking Act of 1935 made the FDIC a permanent government agency and increased the maximum amount of insured deposits to $5,000. This law also further defined the FOMC, giving the Committee its current structure: the seven Governors on the Board of Governors and five of the 12 Reserve Bank presidents. One of the voting members is always the president of the New York Fed; the other four presidents serve one-year terms on a rotating basis. The
Reserve Banks are required to carry out the directions of the FOMC, whose open market operations are centralized at the Open Market Trading Desk at the New York Fed. The 1935 law also changed the title of Reserve Bank heads from governor to president and removed the Comptroller of the Currency and the Secretary of the Treasury from their positions on the Federal Reserve Board.

Going to War

World War II carried the American economy out of the Great Depression. Producing armaments and other goods for the war kept the economy buzzing in the early to mid-1940s. During this period, the Federal Reserve acted at the Treasury’s request to keep rates low to help finance the war. After 1945, when the war was over, the Treasury wanted the Fed to continue to keep interest rates low.

But the Federal Reserve Act did not specifically set goals for monetary policy, stating instead that the Fed was required to furnish an “elastic currency.” In 1946, Congress passed the Employment Act, which defines the goals of monetary policy to include promoting “maximum employment, production, and purchasing power.”

In 1950, the Treasury pressed the Fed to maintain low rates at the start of the Korean War. However, the central bank was reluctant to do so. Finally, in 1951, the two parties signed the Treasury-Fed Accord, which acknowledged the Fed’s independence in setting monetary policy.

The economy entered another recession in the mid-1950s. Once recovery was underway, the Fed raised interest rates above 3 percent to restrain inflation. But its actions were not fast enough to keep inflation from reaching nearly 4 percent. When a second recession began in mid-1957 and unemployment rose dramatically, the Fed responded with a sharp drop in interest rates to spur spending and employment.

Looking Out for the Consumer

In the 1960s and 1970s, Congress passed several important consumer protection laws, including the Truth in Lending Act in 1968, which requires lenders to disclose the cost of borrowing to consumers; the Equal Credit Opportunity Act in 1974, which combats discrimination in consumer and business lending; and the Electronic Fund Transfer Act in 1978, which provides protection for consumers in their electronic financial transactions. In 1977, Congress passed the Community Reinvestment Act, which encourages banks to meet the credit needs of all segments in their communities. This act also established a community affairs function at the Board of Governors and at each Reserve Bank.

Congress also passed the Full Employment and Balanced Growth Act of 1978, otherwise known as the Humphrey-Hawkins Act. This law expanded the goals of the Employment Act of 1946 and required the Federal Reserve’s chairman to testify to Congress twice each year about the Fed’s objectives and plans for monetary policy.

High inflation and high unemployment plagued the country during the 1970s; inflation climbed to about 6 percent at the start of the decade. With inflation still above 4 percent by mid-1971, President Richard Nixon imposed wage and price controls, which suppressed inflation for a time. The Fed tightened monetary policy when inflation rebounded following the end of the wage and price controls and a jump in oil prices during 1973-74.

Inflation rose to 12 percent in 1974, ushering in another recession. The Fed eased monetary policy in 1974, and the federal funds rate fell below 5 percent in early 1976. Since the Fed was slow to raise short-term interest rates during the rest of the decade, the Fed’s monetary policy remained expansionary, and the Fed’s stated anti-inflation policy lost credibility.

Although the economy expanded during the 1970s, oil prices jumped several times when oil-producing states tightened supplies. Inflation climbed to 14 percent in 1979 when the revolution in Iran reduced oil supplies to the U.S.

President Jimmy Carter appointed Paul Volcker as chairman of the Federal Reserve Board of Governors in 1979, and Volcker took decisive actions to curb inflation. Rather than targeting a short-term interest rate, the Federal Reserve under Volcker focused on controlling the growth of the money supply. This led to higher interest rates, but it succeeded in reducing inflation and lowering interest rates over time.

The Changing Fed

The Depository Institutions Deregulation and Monetary Control Act of 1980 (MCA) changed the way the Fed provides services. The law mandated that the Federal Reserve offer payment services not only to member banks but also to any depository institution that wanted to use them and to charge all institutions (both member and nonmember banks) an amount sufficient to cover the cost of providing the service; the law also granted depository institutions equal access to discount window lending. In return, the MCA requires all banks to maintain
reserves with the Fed.

In the 1980s and 1990s, more deregulation came to the banking industry. The Riegle-Neal Interstate Banking and Branching Efficiency Act of 1994 allowed banks to set up branches in other states. The Financial Services Modernization Act of 1999, also called the Gramm-Leach-
Bliley Act, repealed the requirement that investment and commercial banking be separate, a provision that was originally set forth in the Glass-Steagall Act of 1933.

After the world ushered in a new millennium, the terrorist attacks of September 11, 2001, forever changed life in America. In the days and weeks that followed, the Fed maintained financial stability and kept the economy moving by pumping liquidity into U.S. financial markets. The Fed kept the payments system and banking operations as close to normal as possible. The attacks also generated new payment systems since all air transportation was grounded for several days after 9/11. The Fed couldn’t move checks from one part of the country to another by
air, so it stepped in to keep the financial system operational. The Fed credited the accounts of the banks receiving check payments and waited to debit the accounts of
the paying banks until planes began flying again.

The Fed asked Congress to enact a law that would allow a substitute check to be legally acceptable for collection and payment. And in 2003, Congress passed the Check Clearing for the 21st Century Act, commonly called Check 21. This legislation, which went into effect in October 2004, reduced the time it took banks to clear checks: An electronic image was sent instead of the actual paper check.

In 2007, the Fed had to face yet another financial crisis and ensuing deep recession. This time, the Fed didn’t waste time in taking extraordinary steps: It lowered short-term interest rates to near zero, established special lending programs, expanded traditional
overnight loans through the discount window to 90 days, and supported the functioning of credit markets through open market purchases of long-term securities for the Fed’s portfolio. In July 2010, Congress passed the Dodd-Frank Wall Street Reform and Consumer Protection Act, which resulted in three significant changes for the Federal Reserve.

First, Congress expanded the Fed’s regulatory role by adding savings and loan holding companies to the Fed’s supervisory activities. The Fed was also given supervisory authority over systemically important nonbank financial companies. Congress also created the Financial Stability Oversight Council to conduct surveillance and monitor risks to the financial system.

Second, Congress limited the Fed’s role under Section 13(3) of the Federal Reserve Act as lender of last resort in unusual and exigent circumstances. During the financial crisis, the Fed used this authority to make $182 billion in loans to the American International Group (AIG) to prevent it from filing for bankruptcy, which would have destabilized the global financial system because of AIG’s size.

Finally, Congress transferred the Fed’s authority to write regulations for most federal consumer protection laws to the newly created Consumer Financial Protection Bureau
(CFPB). Although Dodd-Frank funded the CFPB through the Fed, the new bureau is independent of the Fed in terms of its decision-making authority.

Living History On December 16, 2013, more than 80 Federal Reserve Board officials gathered in Washington, D.C., to commemorate the signing of the Federal Reserve Act. Four Federal Reserve System Chairs whose service has spanned 35 years were on hand; from left to right, Janet Yellen (2014-ongoing), the first woman to be appointed Chair; Alan Greenspan (1987-2006), Ben Bernanke (2006-14), and Paul Volcker (1979-87).VIEW LARGER IMAGE

While rule-making authority for most consumer protection laws was transferred to the CFPB, the Fed and federal agencies still had the authority to write regulations for certain federal laws, including the Community Reinvestment Act (CRA), the National Flood Insurance Act, and the Expedited Funds Availability Act. And the Fed continues to be the consumer compliance regulator for state member banks with assets of less than $10 billion. It also conducts limited consumer examinations of state member banks with assets of more than $10 billion to ensure compliance with laws that the bureau doesn’t cover in its examinations.

These changes were only the latest the Fed has undergone in the past 100 years. Yet, the economy and the banking industry have also been shaped by changing times. The financial services industry as a whole would be all but unrecognizable to our forebears a hundred years ago. Unlike its predecessors, the Fed has weathered the political storms of its day. It insulated itself from partisan politics, but it is clearly accountable to Congress and the American people. Its decentralized structure has kept it close to the economy on Main Streets throughout America. And that has made it ready to tackle the challenges to come
as the Fed enters its second century of service as the nation’s central bank.

For more information on the history of central banking, see
the ongoing series published by the Federal Reserve Bank of
Philadelphia. See more information on the Federal Reserve System’s centennial.